Week 14

foreign exchange market (14.1)

- A foreign exchange market is a market in which various currencies are exchanged for one another. The equilibrium prices in such currency markets are called exchange rates.

domestic jobs argument (14.2)

- if we place tariffs on foreign car parts then our consumers will have to buy domestic car parts - that will lead to an increase in money and revenue for our economy leading to more jobs - trade barriers lead to more jobs in the protected industry

protectionism point (14.2)

After all, if protectionism did not benefit domestic producers, there would not be much point in enacting such policies in the first place. Protectionism is simply a method of requiring consumers to subsidize producers. The subsidy is indirect, since consumers pay for it through higher prices, rather than a direct government subsidy paid with money collected from taxpayers. However, protectionism works like a subsidy, nonetheless.

dumping (14.2)

Dumping occurs when a foreign firm deliberately sells goods below their cost in an attempt to drive the domestic industry out of business. Once the domestic industry is gone, the foreign firm is then free to raise prices to whatever level they desire, which is predatory pricing.

protectionism (14.2)

Government policies to reduce or block imports.

Refer to Figure 9!!! (14.1)

Graphically, you can see that if a currency is experiencing relatively high inflation, then its buying power is decreasing and international investors will be less eager to hold it. Thus, a rise in inflation in the Mexican peso would lead demand to shift from D0 to D1 (see Figure 9 below), and supply to increase from S0 to S1. Both movements in demand and supply would cause the currency to depreciate. Here, we draw the effect on the quantity traded as a decrease, but in truth, it could be an increase or no change, depending on the actual movements of demand and supply.

Figure 5 (14.1)

Refer to Figure 5!! - make sure to understand it As the exchange rate changes, it affects our users differently. For example, if the U.S. dollar appreciates, then a U.S. exporting firm will not do well as their good will become more expensive to foreign buyers. But a U.S. tourist abroad will do well, as they will be able to buy more of the foreign currency and spend more there.

export promotion (14.2)

Refers to a growth and trade strategy where a country attempts to achieve economic growth by expanding its exports. As a trade and strategy, it looks outward towards foreign markets and is based on stronger links between domestic and global economies.

tariffs (14.2)

Taxes that governments place on imported goods.

Refer to Figure 14!!!

Understand the scenarios.

If government policy allows a country's currency to be determined in the exchange rate market, then that currency will be subject to: (14.1)

a floating exchange rate

A rule that every imported product must be opened by hand and inspected with a magnifying glass, by one of just three government inspectors available at any given time might be referred to as __________________. (14.2)

a non-tariff barrier

What will happen to the usa dollar if more europeans travel to usa? (14.1)

dollar will appreciate cuz the demand is increasing for our dollar

The infant industry argument for protectionism suggests that an industry must be protected in the early stages of its development so that: (14.2)

domestic producers can attain the economies of scale to allow them to compete in world markets

If a central bank focuses on preventing either high inflation or deep recession by using low and reasonably steady interest rate policy, then: (14.1)

exchange rates will have less reason to vary

An import quota or tariff on French wine that raises the prices for wine will probably: (14.2)

hurt domestic wine drinkers but help domestic wineries, which will gain from the higher prices

point (14.1)

if we supply more dollars to other countries by spending more, our dollar will depreciate

If Australia's exchange rate is stronger than the PPP rate for several years, which of the following will likely result? (14.1)

its imports will increase

________________________ equalizes the prices of internationally traded goods across countries. (14.1)

purchasing power parity

When Mateo buys Euros through _________________________, he will use his U.S. dollars to pay for them. (14.1)

the foreign exchange market

point (14.2)

those who have a comparative disadvantage in trade are those who would be hurt most by free trade

A depreciating U.S. dollar is ________________ because it is worth ___________ in terms of other currencies. (14.1)

weakening; less

Refer to Figure 13!!! (14.1)

- (a) If an exchange rate is pegged below what would otherwise be the equilibrium, then the currency's quantity demanded will exceed the quantity supplied. (b) If an exchange rate is pegged above what would otherwise be the equilibrium, then the currency's quantity supplied exceeds the quantity demanded. - However, Brazil's government decides that the exchange rate should be 30 cents/real, as shown below. Perhaps Brazil sets this lower exchange rate to benefit its export industries. Perhaps it is an attempt to stimulate aggregate demand by stimulating exports. Perhaps Brazil believes that the current market exchange rate is higher than the long-term purchasing power parity value of the real, so it is minimizing fluctuations in the real by keeping it at this lower rate. Perhaps the government set the target exchange rate sometime in the past, and it is now maintaining it for the sake of stability.

floating exchange rate (14.1)

- A country lets the exchange rate market determine its currency's value. - They can be volatile and unpredictable and because of that, they may discourage international trade. This instability can destabilize domestic economies as the wide fluctuations stimulate and then depress industries involved in exporting goods.

key ideas (14.1)

- In the foreign exchange market, people and firms exchange one currency to purchase another currency. - Currency can appreciate or depreciate based upon demand and supply for currency: it is an inverse relationship. - A stronger currency has those whom benefit, while others are hurt. A weaker currency has those whom benefit, while others are hurt. - Determinants shift the demand and supply for currency. - Central banks monitor exchange rates.

point (14.1)

- The depreciation of one currency correlates to the appreciation of the other and vice versa. When comparing the exchange rates between two countries, the depreciation (or weakening) of one country (like the U.S. dollar here) indicates the appreciation (or strengthening) of the other currency (like the Canadian dollar). - A fall in the Canada $/U.S. $ ratio means a rise in the U.S. $/Canada $ ratio, and vice versa.

key ideas (14.2)

- When a country places limitations on imports from abroad, regardless of whether it uses tariffs, quotas, or non-tariff barriers, it is said to be practicing protectionism. - Protectionism will raise the price of the protected good in the domestic market, which causes domestic consumers to pay more, but domestic producers to earn more. - As international trade increases, it contributes to a shift in jobs away from industries where that economy does not have a comparative advantage and toward industries where it does have a comparative advantage. - Arguments supporting restricting imports are based around industry and competition, environmental concerns, and issues of safety and security. - Governments determine trade policy at many different levels: administrative agencies within government, laws passed by the legislature, regional negotiations between a small group of nations (sometimes just two), and global negotiations through the World Trade Organization.

depreciating (14.1)

- When the value of a currency falls, so that a currency trades for less of other currencies, the exchange rate is described as depreciating or "weakening." This means there is an inverse relationship occurring. When one appreciates (goes up), the other depreciates (goes down). - When a currency is worth less in terms of other currencies; also called "weakening".

appreciating (14.1)

- When the value of a currency rises, so that the currency exchanges for more of other currencies, the exchange rate is described as appreciating or "strengthening." - When a currency is worth more in terms of other currencies; also called "strengthening".

supply of the U.S. dollar comes from: (14.1)

- a foreign firm that has sold imported goods in the usa, earned usa dollars, and is trying to pay expenses incurred in its home country - usa tourists leaving to visit other countries - usa investors who want to make foreign direct investments in other countries - usa investors who want to make portfolio investments in other countries

demand for the U.S. dollar comes from: (14.1)

- a usa exporting firm that earned foreign currency and is trying to pay usa-based expenses - foreign tourists visiting the usa - foreign investors who wish to make direct investments in usa economy - foreign investors who wish to make portfolio investments in the usa economy

point (14.1)

- if we decrease interest rates, that will decrease demand for our goods/dollar shifting demand to the left - if we bought more chinese currencies, supply would increase/shift to right for american dollars - we could set a limit on who buys our goods, that would cause our dollar to decrease in demand or go back to equilibrium after appreciation - countries may want fixed exchange rates to help keep exchange rates low so exports increase

point (14.2)

- if we protect car parts industry, it will cost more money for consumers and a decrease in supply in other industries which leads to a decrease in jobs in those other industries - government receives more money if there's more tariffs in place - govt also receives money from sale of quota license

full integration (14.2)

- involves a single economic market, a common trade policy, a single currency, a common monetary policy, together with a single fiscal policy, including common tax and benefit rates - USA is example of this

health and safety regulations (14.2)

- rules for employers and employees to follow in order to keep their workplace healthy and safe - regulations on GMOs

4x things that can shift foreign exchange adas graph (14.1)

- tastes and preferences - income - price level - interest rates

voluntary export restraint (14.2)

- when a foreign country volunteers to restrict its exports into another country's market

order of trade blocs from least to most detailed (14.2)

1. preferential trade area 2. free trade area 3. customs union 4. common market 5. economic union 6. full integration

tariff revenue (14.2)

= T x (Qd-Qs)

quota (14.2)

A quota is a limit on the amount of a particular good that could be imported in a given amount of time. By limiting the supply, you drive the price up, thereby making the imported good more expensive than its domestic competitor. This makes Toyota even unhappier as they are making even less of a profit. They may choose to take the high tariff instead, because they make more of a profit, even with the tariff.

Which of the following is the best example of a quota? (14.2)

A. a tax placed on all small cars sold in the domestic market B. a limit imposed on the number of men's suits that can be imported from a foreign country C. a subsidy from the American government to domestic manufacturers of men's suits so they can compete more effectively with foreign producers of men's suits D. a $100-per-car fee imposed on all small cars imported Answer: B

Which of the following is the best example of a tariff? (14.2)

A. a tax placed on all small cars sold in the domestic market B. a limit imposed on the number of small cars that can be imported from a foreign country C. a subsidy from the American government to domestic manufacturers of small cars so they can compete more effectively with foreign producers of small cars D. a $1000-per-car fee imposed on all small cars imported Answer: D

trade blocs (14.2)

An agreement between states, regions, or countries, to reduce barriers to trade between the participating regions.

Refer to Figure 7!!! (14.1)

An announcement that the peso exchange rate is likely to strengthen in the future will lead to greater demand for the peso from investors who wish to benefit from the appreciation (from D0 to D1 in Figure 7 below). Similarly, it will make investors less likely to supply pesos to the foreign exchange market (from S0 to S1). Both the shift of demand to the right and the shift of supply to the left cause an immediate appreciation in the exchange rate. The profit motive drives most investments. If rates of return are relatively high, then that country will tend to attract funds from abroad. The opposite is true: if rates look low, the funds will be utilized in other economies. This will cause shifts in the demand and supply for a currency.

hard peg (14.1)

An exchange rate policy in which the central bank sets a fixed and unchanging value for the exchange rate.

soft peg (14.1)

An exchange rate policy in which the government usually allows the market to set the exchange rate, but in some cases, especially if the exchange rate seems to be moving rapidly in one direction, the central bank will intervene.

exchange rates (14.1)

And what are exchange rates based upon? You guessed it! Supply and demand 😊 . An exchange rate is nothing more than a price, that is, the price of one currency in terms of another currency, which is why we can analyze it with the tools of supply and demand.

central bank role (14.1)

Banks play a vital role in any economy in facilitating transactions and in making loans to firms and consumers. When most of a country's largest banks become bankrupt simultaneously, a sharp decline in aggregate demand and a deep recession results. Since the main responsibilities of a central bank are to control the money supply and to ensure that the banking system is stable, a central bank must be concerned about whether large and unexpected exchange rate depreciation will drive most of the country's existing banks into bankruptcy.

Figure 1!!! (14.2)

Consider two countries, Brazil and the United States, who produce sugar (Figure 1). Each country has a domestic demand and supply for sugar. Before trade, the equilibrium price of sugar in Brazil is 12 cents a pound and 24 cents per pound in the United States (points E). When trade is allowed, businesses will buy cheap sugar in Brazil and sell it in the United States. This will result in higher prices in Brazil and lower prices in the United States. Free trade results in gains from trade. Total surplus increases in both countries, as the two blue-shaded areas show in Figure 3. However, there are clear income distribution effects. Producers gain in the exporting country, while consumers lose; and in the importing country, consumers gain and producers lose. When there is free trade, the equilibrium is at point A (see Figure 4). When there is no trade (due to barriers), the equilibrium is at point E. For protected producers like U.S. sugar farmers, restricting imports is clearly positive. Without a need to face imported products, these producers are able to sell more, at a higher price. For consumers in the country with the protected good, in this case U.S. sugar consumers, restricting imports is clearly negative. They end up buying a lower quantity of the good and paying a higher price for what they do buy, compared to the equilibrium price and quantity with trade.

Refer to Figure 8!!! (14.1)

Delving in, we see a higher rate of return for U.S. dollars makes holding dollars more attractive. Thus, the demand for dollars in the foreign exchange market shifts to the right, from D0 to D1 (see Figure 8), while the supply of dollars shifts to the left, from S0 to S1. The new equilibrium (E1) has a stronger exchange rate than the original equilibrium (E0), but in this example, the equilibrium quantity traded does not change. We know inflation impacts one's purchasing power. It also applies to the purchasing power of currency. If a country experiences a relatively high inflation rate compared with other economies, it will tend to discourage anyone from wanting to acquire or to hold the currency.

economic union (14.2)

Economic agreement between countries to allow free trade between members, a common external trade policy, and coordinated monetary and fiscal policies.

common market (14.2)

Economic agreement between countries to allow free trade in goods, services, labor, and financial capital between members while having a common external trade policy.

Refer to Figure 11!!! (14.1)

Exchange rate policies come in a range of different forms. A nation may adopt one of a variety of exchange rate regimes, from floating rates in which the foreign exchange market determines the rates to pegged rates where governments intervene to manage the exchange rate's value, to a common currency where the nation adopts another country or group of countries' currency. Understand Figure 11

ppp functions (14.1)

First, economists often use PPP exchange rates for international comparison of GDP and other economic statistics. The second function of PPP is that exchanges rates will often get closer to it as time passes.

General Agreement on Tariffs and Trade (GATT)/World Trade Organization (WTO)

General Agreement on Tariffs and Trade's (GATT) aim was to provide a forum for multilateral negotiations to reduce trade barriers. Since the enactment of GATT, tariffs on thousands of products have been eliminated or reduced with overall tariffs decreasing by 33%. Each round of negotiations added more countries to the agreement and further increased international trade. GATT became the World Trade Organization (WTO).

point (14.1)

Here, the Brazilian government desires a stronger exchange rate of 40 cents/real than the market rate of 35 cents/real. Perhaps Brazil desires the stronger currency to reduce aggregate demand and to fight inflation, or perhaps Brazil believes that that current market exchange rate is temporarily lower than the long-term rate. Whatever the reason, at the higher desired exchange rate, the quantity supplied of 16 billion reals exceeds the quantity demanded of 14 billion reals.

trade-offs (14.1)

If it uses monetary policy to alter the exchange rate, it then cannot at the same time use monetary policy to address issues of inflation or recession. If it uses direct purchases and sales of foreign currencies in exchange rates, then it must face the issue of how it will handle its reserves of foreign currency.

Refer to Figure 6!!! (14.1)

In graph (a), the quantity measured on the horizontal axis is in U.S. dollars, and the exchange rate on the vertical axis is the price of U.S. dollars measured in Mexican pesos. In graph (b), the quantity measured on the horizontal axis is in Mexican pesos, while the price on the vertical axis is the price of pesos measured in U.S. dollars. In both graphs, the equilibrium exchange rate occurs at point E, at the intersection of the demand curve (D) and the supply curve (S). (This is standard supply and demand displayed here.)

point (14.1)

It is true that in the short and medium run, as exchange rates adjust to relative inflation rates, rates of return, and to expectations about how interest rates and inflation will shift, the exchange rates will often move away from the PPP exchange rate for a time. However, knowing the PPP will allow you to track and predict exchange rate relationships.

You have just been put in charge of trade policy for Malawi. Coffee is a recent crop that is growing well and the Malawian export market is developing. As such, Malawi coffee is an infant industry. Malawi coffee producers come to you and ask for tariff protection from cheap Tanzanian coffee. What sorts of policies will you enact? Explain. (14.2)

It would probably be better to directly subsidize Malawian coffee than to put tariffs on foreign coffee, as this would protect the infant industry while still allowing more consumer choice and the gains from trade, as well as forcing Malawian coffee to face world market prices.

Refer to Figure 10!!! (14.1)

Look at Figure 10 above. A bank in Thailand borrows one million in U.S. dollars. Then the bank converts the dollars to its domestic currency, the baht, at a rate of 40 baht/dollar. The bank then lends the baht to a firm in Thailand. The business repays the loan in baht, and the bank converts it back to U.S. dollars to pay off its original U.S. dollar loan. This process of borrowing in a foreign currency and lending in a domestic currency can work just fine, as long as the exchange rate does not shift. In the scenario outlined, if the dollar strengthens and the baht weakens, a problem arises. The right-hand chain of events in table illustrates what happens when the baht unexpectedly weakens from 40 baht/dollar to 50 baht/dollar. The Thai firm still repays the loan in full to the bank. However, because of the shift in the exchange rate, the bank cannot repay its loan in U.S. dollars. (

infant industry argument (14.2)

New industries in developing countries must be temporarily protected from international competition to help them reach a position where they can compete on world markets with the firms of developed nations.

point (14.1)

One reason to demand a currency on the foreign exchange market is the belief that the currency's value is about to increase. One reason to supply a currency on the foreign exchange market is the expectation that the currency's value is about to decline.

The race to the bottom scenario of global environmental degradation is explained roughly like this: (14.2)

Profit-seeking multinational companies shift their production from countries with strong environmental standards to countries with weak standards, thus reducing their costs and increasing their profits.

Do you think that a country experiencing hyperinflation is more or less likely to have an exchange rate equal to its purchasing power parity value when compared to a country with a low inflation rate? (14.1)

The country experiencing hyperinflation is less likely to have an exchange rate reflecting PPP, because the rapid devaluation of the currency will strongly discourage purchases of that currency regardless of what real price differences are.

arbitrage (14.1)

The process of buying a good and selling goods across borders to take advantage of international price differences.

point (14.1)

The units in which we measure exchange rates can be confusing, because we measure the exchange rate of the U.S. dollar exchange using a different currency: the Canadian dollar. However, exchange rates always measure the price of one unit of currency by using a different currency. If it takes more dollars to buy a Canadian dollar, we would say the dollar has depreciated relative to the Canadian dollar (our exports are cheaper), and if it takes fewer dollars to buy a Canadian dollar, the dollar would have appreciated relative to the Canadian dollar (our exports are more expensive). Exchange rates always measure the price of one unit of currency by using a different currency.

non-tariff barrier (14.2)

Ways a nation can draw up rules, regulations, inspections, and paperwork to make it more costly or difficult to import products.

purchasing power parity (ppp) (14.1)

We call the exchange rate that equalizes the prices of internationally traded goods across countries the purchasing power parity (PPP) exchange rate. The purchasing power parity exchange rate has two functions.

What do the economies of Greece, Ireland and Germany all share? (14.1)

a common currency

Suppose the government of Taiwan subsidized its watch-making industry, enabling Taiwanese producers to undersell foreign watch producers. The law of comparative advantage indicates that watch-importing nations would best take advantage of the Taiwanese subsidization policy by: (14.2)

accepting the subsidy of the Taiwanese government, making the appropriate adjustment for the resources temporarily displaced from the domestic watch-making industry

Politicians often argue for tariff increases in order to reduce the nation's dependence on imports. If tariffs are increased, the long-run effect is most likely to be: (14.2)

an decrease in American imports, and an increase in American exports

common market (14.2)

eliminate internal barriers, adopt common external barriers, allow free movement of resources among member countries

economic union (14.2)

eliminate internal barriers, adopt common external barriers, free movement of resources, and a uniform set of economic policies

customs unions (14.2)

eliminate internal barriers, agree on common external barriers

free trade agreement (14.2)

eliminate internal barriers, but maintain independent external barriers

Expansionary monetary policy lowers ______________, and increases demand for investment and consumer borrowing, which shifts aggregate demand to the ________________. (14.1)

interest rates; right

Smoot-Hawley Tariff Act (14.2)

legislation passed in 1930 that established very high tariffs; its objective was to reduce imports and stimulate the domestic economy, but it resulted only in retaliatory tariffs by other nations

preferential trade area (14.2)

lower but not eliminate, barriers among members

What would happen is interest rates increased in usa? (14.1)

our dollar appreciates since other countries will want to buy more of our bonds for a higher rate of return; we would also be supplying less dollars

What would happen to the usa dollar if there is increase in price level in usa? (14.10

our dollar depreciates but the supply of our dollar goes up since we will spend more in other countries

What would happen to the usa dollar is there is a severe recession in europe? (14.1)

our dollar will depreciate because they would need/buy less of our stuff

Low-wage U.S. workers suffer from protectionism in all the industries that they don't work in, because: (14.2)

protectionism forces them to pay higher prices for basic necessities like clothing and food.

internal rules (14.2)

rules that members follow for behavior among themselves

external rules (14.2)

rules that members follow for behavior with non-members

When a government uses a ______________ exchange rate policy, it usually allows the exchange rate to be set by the market. (14.1)

soft peg

For firms engaged in international lending and borrowing, ____________________ can have an enormous effect on profits. (14.1)

swings in exchange rates

If 112 Japanese yen purchased $1.00 U.S. in 2008 and 83 Japanese yen purchased $1.00 U.S. in 2009, then: (14.1)

the dollar depreciated against the yen

fixed exchange rate (14.1)

the govt manipulates the value of a country's currency

If Japan does not have a comparative advantage in producing rice, the consequences of adopting a Japanese policy reducing or eliminating imports of rice into the country would include: (14.2)

the real incomes of Japanese rice producers would rise, but the real incomes of Japanese rice consumers would fall